The Municipal Securities Rulemaking Board (“MSRB”) is requesting comment on draft Rule G-43 (on broker’s brokers), as well as associated draft amendments to Rule G-8 (on books and records), G-9 (on records preservation), and G-18 (on execution of transactions). Under draft Rule G-43(e)(iii), a “broker’s broker” means a broker, dealer, or municipal securities dealer that principally effects transactions for other brokers, dealers, and municipal securities dealers (“dealers”) or that holds itself out as a broker’s broker. A broker’s broker may be a separate business or part of a larger business.

Comments should be submitted no later than April 21, 2011. Comments should be sent via e-mail to CommentLetters@msrb.org. Please indicate the notice number in the subject line of the e-mail. To submit comments via regular mail, please send them to Ronald W. Smith, Corporate Secretary, MSRB, 1900 Duke Street, Alexandria, VA 22314. Written comments will be available for public inspection on the MSRB’s web site.

Questions about this notice should be directed to Peg Henry, Deputy General Counsel, at 703-797-6600.

BACKGROUND

Both Securities and Exchange Commission (“SEC”) and Financial Industry Regulatory Authority (“FINRA”) enforcement actions have highlighted broker’s broker activities that constitute clear violations of MSRB rules.[1] The MSRB recognizes that some broker’s brokers make considerable efforts to comply with MSRB rules. Given the nature of the rule violations brought to light by SEC and FINRA enforcement actions, however, the MSRB determined that additional guidance and/or rulemaking concerning the activities of broker’s brokers was warranted.

The MSRB published a notice on September 9, 2010 (the “Notice”) requesting comment on draft guidance on the application of existing MSRB rules to broker’s brokers.[2] The MSRB stated in the Notice that some of the guidance might eventually take the form of a rule or rules. The MSRB received comments from seven commenters.[3] After reviewing the comments, the MSRB has determined to request comment on draft Rule G-43 and associated draft amendments to Rule G-8, G-9, and G-18, as an alternative to the draft guidance set forth in the Notice.

The principal provisions of the revised draft amendments are summarized below. This summary is followed by a discussion of the comments received on the draft interpretive guidance set forth in the Notice. The MSRB considered the merits of the comments and made certain revisions to the proposal, as noted below.

SUMMARY OF DRAFT RULE G-43

Draft Rule G-43(a) sets forth the basic duties of a broker’s broker. Draft Rule G-43(a)(i) incorporates the same basic duty currently found in Rule G-18. That is, a broker’s broker must make a reasonable effort to obtain a price for the dealer that is fair and reasonable in relation to prevailing market conditions. The broker’s broker must employ the same care and diligence in doing so as if the transaction were being done for its own account.

Draft Rule G-43(a)(ii) provides that a broker’s broker must not take any action that works against the client’s interest to receive advantageous pricing. Under draft Rule G-43(a)(iii), the potential seller is presumed to be the client of the broker’s broker in a bid-wanted (as defined in draft Rule G-43(e)(ii)), unless both the potential seller and the potential buyers (bidders) both agree in writing to dual representation. This presumption does not apply in the case of offerings (as defined in draft Rule G-43(e)(vi)).

Under draft Rule G-43(a)(iv), if the broker’s broker believes that the highest bid received in a bid-wanted or offering does not represent a fair and reasonable price in relation to prevailing market conditions within a reasonable degree of accuracy, the broker’s broker must disclose that fact to its client or clients, in which case the broker’s broker may still effect the trade, if the client or clients acknowledge such disclosure in writing. This provision of the draft rule does not require that the broker’s broker communicate with the client’s customer. It also does not require the dealer client of the broker’s broker to provide its customer with this disclosure. However, a dealer client that receives this disclosure from a broker’s broker and wishes to accept the highest bid obtained by the broker’s broker will need to satisfy itself that such bid is, in fact, a fair and reasonable price in order to satisfy its duty to its customer under Rule G-30, which requires that the price paid to the customer be fair and reasonable.

Draft Rule G-43(b) and (c) only concern bid-wanteds, not offerings. The Board determined that more detailed guidance on the conduct of bid-wanteds was warranted, because bid-wanteds are a very important component of secondary market liquidity for retail investors in municipal securities, and most of the violations found by the SEC and FINRA have involved bid-wanteds, rather than offerings.

Draft Rule G-43(b) provides that a bid-wanted conducted in a manner that satisfies the requirements of draft Rule G-43(c) will generally satisfy the obligation of a broker’s broker under draft Rule G-43(a)(i) -- to make a reasonable effort to obtain a fair and reasonable price under prevailing market conditions. However, whether the bid-wanted actually satisfies this duty will depend on the specific facts and circumstances of the transaction, including whether the broker’s broker has satisfied its duty of fair dealing under Rule G-17.

Draft Rule G-43(c) provides rules for the conduct of a bid-wanted that a broker’s broker must comply with if the broker’s broker is using the bid-wanted to satisfy its duty under draft Rule G-43(a) (i.e., to make a reasonable effort to obtain a fair and reasonable price under prevailing market conditions). These provisions are designed to increase the likelihood that the highest bid in the bid-wanted is fair and reasonable. Many of the requirements of draft Rule G-43(c) address behavior that would also be a violation of Rule G-17 (e.g., the prohibitions on providing bidders with “last looks” and encouraging off-market bids), although the requirements of draft Rule G-43 would not supplant those of Rule G-17.

Draft Rule G-43(d) provides that a broker’s broker must adopt and follow policies and procedures addressing certain enumerated matters, which are designed to result in a fair process consistent with the special role of the broker’s broker as an intermediary between two dealers. Although the draft rule would not preclude broker’s brokers from having customers, it would prevent them from providing those customers or other dealers not party to a transaction with information about bid prices not available to the general public on an equal basis or information on the ownership of securities.

SUMMARY OF DRAFT AMENDMENTS TO RULES G-8, G-9, AND G-18

The draft amendments to Rule G-8 and Rule G-9 would make it express that broker’s brokers must retain records of all bids received (whether amended or withdrawn) for three years, together with the time of receipt.

Upon adoption of draft Rule G-43, the draft amendments to Rule G-18 would remove the sentence concerning broker’s brokers from Rule G-18, because the same language is included in draft Rule G-43(a)(i).

Comments Received.SIFMA said that the proposed definition of “broker’s broker” does not sufficiently define what a broker’s broker is, or the limited nature of the activities of a broker’s broker. It also said that the clause “or holds itself out as a broker’s broker” is unclear and should be omitted from any final definition.

SIFMA proposed what it referred to as a “function-based definition,”[5] which would provide that a “ municipal securities broker’s broker” is a broker, dealer, or municipal securities dealer that:

acts as a disclosed agent or riskless principal in the purchase or sale of municipal securities for an undisclosed registered dealer, sophisticated municipal market professional (“SMMP”), or institutional counterparty;

does not have or maintain any municipal securities in any proprietary or other accounts, other than for clearance and settlement purposes;

executes equally matched transactions contemporaneously;

does not carry any customer accounts; does not at any time receive or hold customer funds or safekeep customer securities;

does not participate in syndicates;

acts in the limited agency capacity of providing liquidity, market information, order matching, and anonymity through facilitation of transactions in the interdealer market;

does not participate in the decision to buy or sell securities, exercise discretion as to the price at which a transaction is executed, or determine the timing of execution; and

is compensated by a commission, not a mark-up.

MSRB Response. The definition proposed by SIFMA would make it easy for a firm to escape classification as a broker’s broker and, accordingly, avoid application of the rules for broker’s brokers. For example, a firm could simply carry customer accounts and avoid classification as a broker’s broker, because part of the definition of a broker’s broker proposed by SIFMA is that the firm not carry customer accounts. The MSRB continues to believe that the definition of broker’s broker used in the Notice is the appropriate one. The MSRB definition of broker’s broker (in draft Rule G-43(e)(iii)) is a functional definition. It focuses on the key function of a broker’s broker -- effecting transactions in municipal securities on behalf of other dealers.[6] The alternative clause “or holds itself out as a broker’s broker” was included in the definition because the burden should not be on the selling dealer to know whether a firm holding itself out as a broker’s broker, in fact, principally effects trades for other dealers. The key is the nature of the duty that the selling dealer should reasonably expect to have owed to it.

However, the MSRB has decided to address some of the factors identified by SIFMA in draft Rule G-43. Among other things, draft Rule G-43(d)(i)(C) prohibits broker’s brokers from maintaining any municipal securities in any proprietary or other accounts, other than for clearance and settlement purposes, and draft Rule G-43(d)(i)(D) prohibits them from participating in syndicates or similar accounts for the purchase of municipal securities. Draft Rule G-43(d)(i)(E) requires that broker’s brokers execute equally matched trades contemporaneously. Draft Rule G-43(d)(i)(F) does not require that broker’s brokers be compensated by commissions. Instead, it requires that the compensation of the broker’s broker to be disclosed to each contra-party in matched transactions.

Broker’s Brokers as Agents

Comments Received. SIFMA noted that the Notice provides that, for purposes of all MSRB rules, a transaction by a broker’s broker will be considered a principal transaction, rather than an agency transaction, if the securities are held in any account of the broker’s broker, even if only in its clearing account. SIFMA argued that the Notice elevates form over substance.[7] Instead, SIFMA argued, in determining the nature of the transactions, the MSRB should focus on the relationship of the broker’s broker and its counterparties, which SIFMA said is a limited agency relationship.[8] However, SIFMA argued, even if a transaction is effected by a broker’s broker as an agent, the broker’s broker should not be required to disclose the identity of the other side of a transaction or express willingness to do so, as anonymity is one of the primary services that broker’s brokers provide to their counterparties.

TMC argued that broker’s brokers should be permitted to serve as agents for both the potential seller and bidders in all cases.

MSRB Response. Draft Rule G-43 no longer addresses whether broker’s broker trades are principal or agency trades. If a broker’s broker has customers, its pricing obligations to them will be governed by either Rule G-18, in the case of agency trades, or Rule G-30, in the case of principal trades. The MSRB has also not proposed any changes to the dealer confirmation requirements of Rule G-12.

Draft Rule G-43(a)(iii) permits a broker’s broker to act as agent for both potential seller and bidders in: (i) a bid wanted, if it has received consent from the potential seller and bidders or (ii) an offering. Unlike bid-wanteds, in offerings selling dealers notify the broker’s broker at the commencement of the offering of the price they desire or are willing to accept. They understand that broker’s brokers will negotiate between them and bidders during the course of the offering. Offerings also tend to involve larger blocks of securities and more frequently traded securities than those involved in bid-wanteds. Given the abuses that have occurred in bid-wanteds, the MSRB is unwilling to extend this dual agency concept without the express consent of both parties. However, as noted below, the MSRB requests comment on whether an exception should be permitted for electronic trading systems that qualify as broker’s brokers.

Non-Mandatory Guidance

Comments Received. SIFMA supported the steps set forth in the proposed interpretive guidance that may need to be taken to ensure that the bid-wanted process is fair and reasonable, but argued that they should not be mandatory, since “the entire bid gathering process is subject to the control of the seller.”[9]

MSRB Response. Draft Rule G-43(b) provides that a bid-wanted conducted in a manner that satisfies the requirements of the rule concerning bid-wanteds will generally satisfy the obligation of a broker’s broker to use a reasonable effort to obtain a price for the dealer that is fair and reasonable in relation to prevailing market conditions, depending on the specific facts and circumstances of the transaction. The draft rule does not mandate the use of bid-wanteds. However, draft Rule G-43(c) provides that, if the broker’s broker uses a bid-wanted to satisfy its pricing obligation under the rule, the bid-wanted must be conducted in the manner specified by the rule. Given the abuses of bid-wanteds highlighted by the SEC and FINRA enforcement actions, the MSRB considers it appropriate to mandate certain minimum steps that broker’s brokers using bid-wanteds to satisfy their pricing obligation must take to help ensure that bid-wanteds are conducted in a fair and reasonable manner. Selling dealers will also benefit from having bid-wanteds conducted in a uniform manner, subject to procedures designed to minimize unfair conduct. Draft Rule G-43 would not preclude a broker’s broker from using a bid-wanted process that does not meet all of the provisions of section (c) thereof, but such process would be less effective in establishing that the broker’s broker has used reasonable efforts to obtain a fair and reasonable price in relation to prevailing market conditions as required under draft Rule G-43(a)(i) and would require greater evidence of other steps taken by the broker’s broker to obtain such price.

Rule G-18 Standard Not Appropriate for Broker’s Brokers

Comments Received. TMC and Wolfe & Hurst both argued that broker’s brokers should not be required to employ the same standard of care and diligence in executing transactions as if the transactions were being done for their own account. They said that this standard should only apply to dealers in transactions with customers.

MSRB Response. The MSRB disagrees with this comment, given the important role that broker’s brokers play in the secondary market for municipal securities, and particularly the provision of liquidity for retail investors. However, the MSRB is seeking comment on whether there should be an exception for an auction process conducted on an electronic trading system by a broker’s broker, without voice brokerage.

“Process-Based Rule”

Comments Received.SIFMA argued that the proposed guidance would change the rule from a “process-based rule” to an “outcome-based rule” by requiring broker’s brokers to determine whether the price resulting from a bid-wanted is reasonable and notifying the selling dealer in writing if the broker’s broker cannot make that determination. SIFMA said that Rule G-18 does not require dealers effecting agency trades for customers to take these actions[10] and that the proposed guidance inappropriately places the primary burden on whether a transaction should occur on the broker’s broker, rather than on the selling dealer. SIFMA argued that the selling dealer is in a better position to make a determination of whether a price is fair than is a broker’s broker.

MSRB Response. The MSRB disagrees with SIFMA that the duty of a broker’s broker is solely to conduct a well-run bid-wanted. As provided in existing Rule G-18, a broker’s broker has an obligation to its dealer client to make a reasonable effort to obtain a fair and reasonable price in relation to market conditions. However, as the MSRB stated in 2004, a widely disseminated and properly run bid-wanted will offer important and valuable information on the fair market value of a security. Accordingly, draft Rule G-43(b) provides that a bid-wanted conducted in a manner that satisfies the requirements of the rule concerning bid-wanteds will generally satisfy the obligation of a broker’s broker to use a reasonable effort to obtain a price for the dealer that is fair and reasonable in relation to prevailing market conditions, depending on the specific facts and circumstances of the transaction.

SIFMA noted that “[e]stablished and reputable [broker’s brokers] maintain full trading history on all items; bid-wanted items (full description of all bid-wanted items), bid pads (programs containing the history of all firms that bid the item and the levels they bid, as well as PASS history, i.e., all firms that passed on bidding the item), execution history and ticketing/operational history.” “The advantage that [broker’s brokers] have in the market is their continuous communication with the dealer community or “Street.” “[Broker’s brokers] often acquire knowledge of the various sectors of the municipal bond market, knowledge that individual dealers/banks may not have developed. It takes a considerable amount of effort, expense, and determination for [a broker’s broker] to acquire sufficient knowledge of any local market . . . .” The draft rule would merely require that broker’s brokers use this knowledge or other established industry sources of information, such as the MSRB’s Electronic Municipal Market Access (“EMMA”) system, to help confirm that their primary method of obtaining a price for the security is reasonable. The MSRB expects that, if broker’s brokers were selling securities for their own account, they would take all of their knowledge about the securities into account in determining whether the bid-wanted had resulted in a fair and reasonable price.

The draft rule concerns the activities of broker’s brokers. Draft Rule G-43 does not draw an analogy between the duty of a broker’s broker and the duty of a dealer serving as agent to a customer. It also does not address whether Rule G-17 would already require a dealer effecting an agency trade for a customer to provide disclosure if it did not consider the trade price to be fair and reasonable. The MSRB will consider issuing further guidance on that subject in the future.

Duty of Broker’s Broker

Comments Received. SIFMA objected to the proposal that if, after a reasonable effort, the broker’s broker cannot determine a fair and reasonable price within a reasonable degree of accuracy, the broker’s broker may still effect the trade with its dealer client if it discloses that fact to the dealer client and the selling dealer acknowledges such disclosure in writing. SIFMA argued that this provision “places the primary burden of determining whether a transaction should occur on the [broker’s broker], rather than on the sellers of the securities.”[11]

MSRB Response. The information about the value of municipal securities provided to a selling dealer by a broker’s broker is only one factor that the dealer must take into account in determining a fair and reasonable price for its customer. In fact, in 2004, the National Association of Securities Dealers (“NASD”) announced that it had fined eight dealers for relying solely on prices obtained in bid-wanteds conducted by broker’s brokers, which the NASD found to be significantly below fair market value.[12] In that same year, the MSRB said that “particularly when the market value of an issue is not known, a dealer (or a broker’s broker subject to the requirements of Rule G-18) may need to check the results of the bid wanted process against other objective data to fulfill its fair pricing obligations . . . .”

Draft G-43(a)(iv) only requires that the broker’s broker notify its client that it has not been able to determine a fair and reasonable price for the securities in relation to prevailing market conditions. The broker’s broker is not required to provide notice to other parties, including the selling dealer’s customer.[13] The selling dealer is then on notice that it must take additional steps to determine a fair and reasonable price for the securities. For example, a selling dealer may be aware of events unknown to the broker’s broker, because they are not required to be reported to the MSRB’s EMMA system, which may have a material effect on the price of the security.

Harm to Secondary Market

SIFMA argued that, as a result of the required notice and required selling dealer acknowledgement, “the secondary market for municipal securities could be harmed because dealers may be discouraged from committing capital to the municipal securities secondary market, especially to lower-rated securities, retail-sized blocks and any security in a volatile market.”[14]

MSRB Response. SIFMA’s main objection seems to be that the provision of such notice, coupled with a requirement of written acknowledgement by the client or in certain cases clients, would slow down trading and discourage the purchase of retail blocks of securities, because dealers might have to do their own research to determine fair market value. The MSRB believes that most retail customers would prefer a better price to a speedy trade. Furthermore, the MSRB considers SIFMA’s argument to be exaggerated and perilous. If a well-run bid-wanted is an effective means of determining fair market value, there should be few instances in which a broker’s broker would need to provide its client or clients with notice that it could not determine a fair and reasonable price for securities in relation to prevailing market conditions with a reasonable degree of accuracy. This notice assists dealers by putting them on notice as to which potential trades require particular scrutiny. SIFMA’s letter contains a list of the various sources of information to which dealers have access to assist them in making pricing determinations, in addition to the information they receive from broker’s brokers.

Alternative to Proposed Disclosure re Pricing

Comments Received. Hartfield, Titus suggested that, as an alternative to the requirement that a broker’s broker provide written disclosure to its client when it could not determine with a reasonable degree of accuracy that the highest bid represented a fair and reasonable price, a broker’s broker should inform the selling dealer if it had reason to believe that a bid was either above or below certain parameters that the broker’s broker would establish for this purpose and disclose to dealers. The broker’s broker would then follow the dealer’s directions on what actions to take.

MSRB Response. The fact that a bid deviates significantly from recent trade prices for the same security may be one indication to the broker’s broker that the bid may not represent a fair and reasonable price under prevailing market conditions and cause the broker’s broker to communicate that concern to the selling dealer. See the discussion of comments received on erroneous bids, below.

Customers

Comments Received. Wolfe & Hurst commented that, “The use of a business model by broker’s brokers that authorizes transactions with institutions and SMMPs permits unfair dealing and should be prohibited.”

SIFMA made a number of comments about the sections of the Notice concerning customers of broker’s brokers. It stated that the proposed guidance regarding transactions with customers does not appropriately reflect the limited and sophisticated nature of the counterparties of broker’s brokers, which are either SMMPs or other institutional investors. Furthermore, SIFMA argued, the MSRB should consider revising its definition of SMMP to allow more institutional customers to qualify as SMMPs. For example, SIFMA objected to the requirement that, to be an SMMP, an institutional investor must have at least $100 million invested in municipal securities in the aggregate in its portfolio and/or under management. SIFMA said that broker’s brokers should be able to choose the means by which they disclose to their dealer clients that they also have customers (e.g., website disclosure or written communications to all counterparties including other important information). While SIFMA agreed that counterparty-specific information should not be shared with other counterparties, it argued that the MSRB proposal would appear to prohibit any market-related communication from a broker’s broker to a customer. It said that information about current bids for similar securities is useful information that broker’s brokers should be able to share.[15]

MSRB Response. The MSRB is concerned that precluding broker’s brokers from having customers might be viewed as anti-competitive. However, the MSRB is also concerned about potential abuses attributable to customer relationships and, as noted below, specifically requests comment on whether a broker’s broker should be permitted to have customers. The MSRB has determined not to change the definition of SMMP at this time. Draft Rule G-43(d)(i)(H) permits a broker’s broker to provide any person, including customers, with information about bid prices if the broker’s broker makes such information available to all market participants on an equal basis at no cost, together with disclosure that any bids may not represent the fair market value of the securities, and discloses publicly that it will make such information public. Otherwise, it may only disclose information about bid prices to its selling dealer client and, in the case of the winning bidder, the cover bid. Draft Rule G-43(d)(i)(I), however, prohibits a broker’s broker from disclosing non-public information about the ownership of municipal securities to any person, including customers. The draft rule also provides for the disclosure by broker’s brokers that they have customers to be in writing, with the specific manner left to the discretion of the broker’s broker.

Self-Dealing

Comments Received. SIFMA agreed with the provisions of the proposed guidance that preclude self-dealing by a broker’s broker and stated that broker’s brokers should never trade securities for their own account.

Comments Received. SIFMA said that broker’s brokers should be able to contact bidders for clarification if their bids are “clearly erroneous,”[16] stating that the acceptance of clearly erroneous bids is a violation of Rule G-13 (on quotations relating to municipal securities).[17] SIFMA argued that a requirement that a broker’s broker contact all bidders in a bid-wanted, rather than only a particular bidder, could lead to unintended consequences to the detriment of the auction process. Furthermore, SIFMA said that broker’s brokers should be able to let bidders know where they stand in the bid process after the deadline for the submission of bids.[18]

MSRB Response. The MSRB is concerned that bid-wanteds have been conducted in a manner in which broker’s brokers engage in discussions with selected potential bidders throughout the bid-wanted, and certain bidders have developed the practice of waiting until very late in the process to submit their bids after they have been told that bids have been placed that potential sellers find to be acceptable. There is too much opportunity for abuse if broker’s brokers are allowed to contact bidders selectively regarding bid prices prior to the deadline for the submission of bids. In the past, broker’s brokers have used such communications to suggest indirectly to bidders that they could lower their bids and still submit winning bids. The MSRB does not believe that it is sufficiently protective of the integrity of the bid-wanted process to rely on the certifications of broker’s brokers that their communications with bidders only concern “clear errors.” Draft Rule G-43(c)(vi) generally permits such contacts only after the bid deadline and does not permit bids to be changed after the deadline.

The MSRB does not consider the acceptance of a bid and communication of that bid to the selling dealer alone to be the publication or distribution of a quote within the meaning of Rule G-13. Nevertheless, the MSRB is concerned that certain trades may be effected at erroneous prices and that such prices will then be reported on EMMA within 15 minutes, creating a misperception about the true fair market value for such securities. Accordingly, Rule G-43(c)(vi) permits broker’s brokers to notify bidders about potential errors in their bids in two ways: (1) First, the broker’s broker may contact the particular bidder that it suspects has submitted a bid in error after first receiving written permission from the selling dealer to do so. This writing may take the form of an e-mail or other electronic communication. (2) Second, the broker’s broker may notify all bidders for the security that a potentially erroneous bid for the security has been submitted and offer all bidders the opportunity to adjust their bids. In order to utilize this second alternative, the broker’s broker must have provided advance disclosure to the client that such communications may occur and all bidders are given the opportunity to adjust their bids. This disclosure may be provided in the terms and conditions of the broker’s broker services previously agreed to by the client.

As noted below, the MSRB requests comment on whether the MSRB should permit electronic trading systems to satisfy the requirements of draft Rule G-43(a)(iv) and (c)(vi) by providing notification to a bidder of a potentially erroneous bid by means of an automatically generated electronic communication to such bidder that its bid deviates from the most recently reported trades for the security by more than a pre-determined amount, coupled with an automatic electronic direction that the bidder must re-submit its bid if it wishes the bid to be accepted.

Rule G-17

Comments Received. SIFMA agreed that it is inconsistent with Rule G-17 to submit fake cover bids, adjust a bid without the bidder’s knowledge, fail to inform the selling dealer of the highest bid, accept bids after a sharp bid deadline, or submit fictitious trade prices.[19]

Comments Received. SIFMA agreed that broker’s brokers should be required to keep records of all bids, together with the time of receipt, and that broker’s brokers should be prohibited from overwriting bids.

MSRB Response. The draft amendments to Rules G-8 and G-9 contain these requirements.

Bid Deadlines

Comments Received. TMC argued there should be no precise deadlines for the submission of bids.

MSRB Response. Draft Rule G-43(c)(v) does not require that there be a precise deadline for the submission of bids. However, it does provide that, if there is a precise or “sharp” bid deadline, the broker’s broker may not accept bids after that deadline or allow bids to be changed after that deadline.

* * * * *

The MSRB requests comment on all aspects of the proposal, including in particular: (i) whether a broker’s broker should be permitted to have customers; (ii) whether the rules for electronic trading systems that qualify as broker’s brokers should differ from those for voice brokers and, if so, in what specific manner. With regard to electronic trading systems, the MSRB specifically requests comment on (a) whether dual agency should be permitted in bid-wanteds without the requirement to obtain prior written consent from both the selling dealer and bidders; and (b) whether the MSRB should permit such systems to satisfy the requirements of draft Rule G-43(a)(iv) and (c)(vi) by providing notification to a bidder of a potentially erroneous bid by means of an automatically generated electronic communication to such bidder that its bid deviates from the most recently reported trades for the security by more than a pre-determined amount, coupled with an automatic electronic direction that the bidder must re-submit its bid if it wishes the bid to be accepted.

February 24, 2011

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Text of Draft Rule G-43

Rule G-43 Broker’s Brokers

(a) Duty of Broker’s Broker.

(i) Each dealer acting as a "broker’s broker" with respect to the execution of a transaction in municipal securities for or on behalf of another dealer shall make a reasonable effort to obtain a price for the dealer that is fair and reasonable in relation to prevailing market conditions. The broker’s broker must employ the same care and diligence in doing so as if the transaction were being done for its own account.

(ii) A broker's broker that undertakes to act for or on behalf of another dealer in connection with a transaction or potential transaction in municipal securities must not take any action that works against the client’s interest to receive advantageous pricing.

(iii) In an offering, a broker’s broker may represent both the potential seller and the bidders. In a bid-wanted, the client of the broker’s broker is presumed to be the potential seller and a broker’s broker may not represent both the potential seller and the bidders unless that is disclosed prominently and both parties agree in writing to such dual representation. In the case of the potential seller, such written agreement must occur at or prior to the time the seller directs the broker’s broker to try to find bidders. In the case of bidders, such written agreement must occur prior to the submission of a bid by such bidder.

(iv) If the broker’s broker believes that the highest bid received in a bid-wanted or offering does not represent a fair and reasonable price in relation to prevailing market conditions within a reasonable degree of accuracy, the broker’s broker must disclose that fact to its client or, if the broker’s broker represents both parties in accordance with paragraph (iii) of this section, clients, in which case the broker’s broker may still effect the trade, if the client or clients acknowledge such disclosure in writing.

(b) Use of Bid-Wanteds. A bid-wanted conducted in a manner that satisfies the requirements of section (c) of this rule will generally satisfy the obligation of a broker’s broker under section (a)(i) of this rule, depending on the specific facts and circumstances of the transaction.

(c) Conduct of Bid-Wanteds. If a bid-wanted is used to help the broker’s broker satisfy its obligation under section (a) of this rule, it must be conducted in the following manner:

(i) A broker’s broker must disseminate a bid-wanted widely (including, but not limited to, the underwriter of the issue and prior known bidders on the issue, to the extent reasonably feasible) to obtain exposure to multiple dealers with possible interest in the block of securities, although no fixed number of bids is required.

(ii) If securities are of limited interest (e.g., small issues with credit quality issues and/or features generally unknown in the market), the broker’s broker must reach dealers with specific knowledge of the issue or known interest in securities of the type being offered.

(iii) A broker’s broker may not encourage off-market bids.

(iv) A broker’s broker may not give preferential information to bidders in bid-wanteds on where they currently stand in the bidding process (including, but not limited to, “last looks,” directions to a specific bidder that it should “review” its bid or that its bid is “sticking out”).

(v) If the broker’s broker or its client has imposed a precise, or “sharp,” deadline for the acceptance of bids, the broker’s broker must not accept bids or changes to bids after the bid deadline.

(vi) A broker’s broker may not contact a bidder in a bid-wanted about its bid price prior to the conclusion of the auction process, unless the broker’s broker believes that the bid has been submitted in error and: (A) the broker’s broker has received written permission from the client to do so, or (B) there is advance disclosure to the client that this may happen and all bidders are given the opportunity to adjust their bids. Otherwise, discussions with bidders during a bid-wanted must be limited to discussions about the characteristics and quality of the security.

(vii) A broker’s broker may not adjust a bid without the bidder’s written instruction.

(viii) A broker’s broker must not fail to inform the selling dealer of the highest bid.

(ix) A broker’s broker must check the results of the bid-wanted process against other objective data (e.g., recent transaction prices for the securities in question or for similar securities).

(d) Policies and Procedures.

(i) As part of the written supervisory procedures required to be adopted, maintained and enforced by a broker’s broker under Rule G-27(c), a broker’s broker must adopt and comply with policies and procedures that:

(A) disclose the nature of its undertaking for the client;

(B) disclose the manner in which the broker’s broker will conduct bid-wanteds and offerings;

(C) prohibit the broker’s broker from maintaining municipal securities in any proprietary or other accounts, other than for clearance and settlement purposes;

(D) prohibit the broker’s broker from participating in syndicates or similar accounts for the purchase of municipal securities;

(F) require the compensation of the broker’s broker to be disclosed to each contra-party in matched transactions;

(G) prohibit self-dealing;

(H) prohibit the broker’s broker from providing any person other than a selling dealer client (that may receive all bid prices) and the winning bidder (that may receive only the price of the cover bid) with information about bid prices, unless the broker’s broker makes such information available to all market participants on an equal basis at no cost, together with disclosure that any bids may not represent the fair market value of the securities, and discloses publicly that it will make such information public;

(I) prohibit the broker’s broker from disclosing confidential, non-public information about the ownership of municipal securities to any person; and

(J) if a broker’s broker has customers, provide for the disclosure of that fact to both sellers and bidders in writing.

(ii) The broker’s broker must disclose the policies and procedures adopted pursuant to subsection (d)(i) of this rule to sellers and bidders in writing at least annually and post such policies and procedures in a prominent position on its website.

(e) Definitions.

(i) “Bidder” means a potential buyer in a bid-wanted or offering.

(ii) “Bid-wanted” means an auction for the sale of municipal securities in which:

(A) the potential seller does not specify a minimum or desired price for the securities that are the subject of the auction at the commencement of the auction;

(B) the identities of the bidders and the potential seller are not disclosed prior to the conclusion of the auction, other than to the broker’s broker;

(C) bidders must submit bids for the auctioned securities to the broker’s broker; and

(D) the potential seller decides whether to accept the winning bid.

(iii) “Broker’s broker” means a dealer, or a separately operated and supervised division or unit of a dealer, that principally effects transactions for other dealers or that holds itself out as a broker’s broker. A broker’s broker may be a separate company or part of a larger company.

(iv) “Cover bid” means the next best bid after the winning bid.

(v) “Dealer” means broker, dealer, or municipal securities dealer.

(vi) For purposes of this rule, “offering” means a process for the sale of municipal securities in which:

(A) the potential seller specifies a minimum or desired price for the securities as part of the offering, at the offering’s commencement;

(B) the identities of the potential seller and the bidders are not disclosed prior to the conclusion of the offering; and

(C) a broker’s broker negotiates between the potential seller and the bidders to arrive at a price acceptable to the parties.

Text of Draft Amendments to Rules G-8, G-9, and G-18

Rule G-8

Books and Records to be Made by Brokers, Dealers and Municipal Securities Dealers

(a) Description of Books and Records Required to be Made. Except as otherwise specifically indicated in this rule, every broker, dealer and municipal securities dealer shall make and keep current the following books and records, to the extent applicable to the business of such broker, dealer or municipal securities dealer:

(i) - (xxiv) No change.

(xxv) Broker’s Brokers. A broker’s broker (as defined in Rule G-43(d)(iii)) shall maintain records of all bids for municipal securities that it receives, together with the time of receipt.

(b) - (e) No change.

(f) Compliance with Rule 17a-3. Brokers, dealers and municipal securities dealers other than bank dealers which are in compliance with rule 17a-3 of the Commission will be deemed to be in compliance with the requirements of this rule, provided that the information required by subparagraph (a)(iv)(D) of this rule as it relates to uncompleted transactions involving customers; paragraph (a)(viii); and paragraphs (a)(xi) through (a)(xxv)(xxiv) shall in any event be maintained.

Rule G-9

Preservation of Records

(a) No change.

(b) Records to be Preserved for Three Years. Every broker, dealer and municipal securities dealer shall preserve the following records for a period of not less than three years:

(i) - (xv) No change.

(xvi) the records to be maintained pursuant to rule G-8(a)(xxii); and

(xvii) the records to be maintained pursuant to Rule G-8(a)(xxiii).; and

(xviii) the records to be maintained pursuant to Rule G-8(a)(xxv).

Rule G-18

Execution of Transactions

Each broker, dealer and municipal securities dealer, when executing a transaction in municipal securities for or on behalf of a customer as agent, shall make a reasonable effort to obtain a price for the customer that is fair and reasonable in relation to prevailing market conditions. A broker, dealer or municipal securities dealer acting as a "broker’s broker" shall be under the same obligation with respect to the execution of a transaction in municipal securities for or on behalf of a broker, dealer, or municipal securities dealer.

[1]FINRA v. Associated Bond Brokers, Inc. Letter of Acceptance, Waiver and Consent No. E052004018001 (November 19, 2007) (settlement in connection with alleged violation of Rule G-17 by broker’s broker due to lowering the highest bids to prices closer to the cover bids without informing either bidders or sellers); FINRA v. Butler Muni, LLC Letter of Acceptance, Waiver and Consent No. 2006007537201 (May 28, 2010) (settlement in connection with alleged violation of Rule G-17 by broker’s broker due to failure to inform the seller of higher bids submitted by the highest bidders); D. M. Keck & Company, Inc. d/b/a Discount Munibrokers, et al., Exchange Act Release No. 56543 (September 27, 2007) (settlement in connection with alleged violation of Rules G-13 and G-17 by broker’s broker for failure to disseminate fake cover bids to both seller and winning bidder; also settlement in connection with alleged violation of Rules G-14 and G-17 by broker’s broker due to payment to seller of more than highest bid on some trades in return for a price lower than the highest bid on other trades, in each case reporting the fictitious trade prices to the MSRB’s Real-Time Trade Reporting System); Regional Brokers, Inc. et al., Exchange Act Release No. 56542 (September 27, 2007) (settlement in connection with alleged violation of Rules G-13 and G-17 by broker’s broker for dissemination of fake cover bids to both seller and winning bidder; broker’s broker allegedly violated Rule G-17 by accepting bids after bid deadline); SEC v. Wolfe & Hurst Bond Brokers, Inc. et al., Exchange Act Release No. 59913 (May 13, 2009) (settlement in connection with alleged violation of Rule G-17 by broker’s broker for dissemination of fake cover bids to both seller and winning bidder and for lowering of the highest bids to prices closer to the cover bids without informing either bidders or sellers). These cases also involved violations of Rules G-8, G-9, and G-28.

[4] The Notice provides: “For purposes of this notice, “broker’s broker” means a broker, dealer, or municipal securities dealer that principally effects transactions for other brokers, dealers, and municipal securities dealers (“dealers”) or that holds itself out as a broker’s broker. A broker’s broker may be a separate company or part of a larger company.”

[6] Currently, “broker’s broker” is not specifically defined by MSRB rules. Pursuant to Rule D-1, therefore, the definition of “broker’s broker” promulgated by the SEC under the Securities Exchange Act of 1934 controls. This definition, developed for purposes of the SEC’s net capital rules, provides: “The term municipal securities "brokers' broker" shall mean a municipal securities broker or dealer who acts exclusively as an undisclosed agent in the purchase or sale of municipal securities for a registered broker or dealer or registered municipal securities dealer, who has no "customers" . . . and who does not have or maintain any municipal securities in its proprietary or other accounts.”